Why Should Passive Investors Not Focus On Fees Syndicators Charge

[Ellie Perlman]

Let’s start from the beginning. It’s a simple fact that most passive investors don’t have the time to put real estate deals together. The work involved in finding the right deal, negotiating the price and doing all the due diligence that goes into formalizing the deal can turn into a full-time job. Many passive investors often don’t have enough experience either. That’s why the best way they can make money by investing in real estate is through syndication.

Syndication has a sponsor or general partner who not only has the experience and real estate knowledge to put a deal together, they often have access to attractive investment opportunities. The sponsor analyzes deals, determines the best investment property, brings investors together and manages the asset once it’s acquired.

How Syndicators Earn Money

In exchange for their months of hard work, sponsors earn fees that include an acquisitions fee, an asset management fee, financing fee and a disposition fee (for managing the sales process when the property sells).

Some passive investors focus on the fees that sponsors earn as well as the equity split between the sponsor and the investors that is part of the deal. These equity splits are often defined as 70%-30% (which means that 70% of the property’s income goes to passive investors and 30% to the sponsor). Regardless of the percentage that’s agreed upon, the bulk of the money goes to the passive investors, or limited partners, while the smaller percentage goes to the sponsor. The reason: Passive investors put up the bulk of the money, so they are compensated appropriately.

Mistaken Emphasis On What Syndicators Charge

The reason some passive investors put too much emphasis on fees and equity splits is that they want to feel they’re participating in a deal that’s extremely favorable to them — and mistakenly assuming that lower fees and equity splits will contribute to the bottom line and increase their overall return. But it just doesn’t always work that way.

If passive investors are working with an experienced sponsor who has a successful track record and they are participating in a strong deal, then they will get the projected returns regardless of the fees or splits. After all, if you invest in a bad or even average deal, the fact that the fees were low or that the equity split was very competitive doesn’t mean you’ll get a higher return on your money. The quality of the deal and the sponsor is what matters — tot their fees.

Inexperienced sponsors often tend to offer lower fees and more favorable equity splits to begin building a track record. Unfortunately, if they don't perform, investors won't receive their projected returns. It's far better to have a 15% internal rate of return (IRR) with a 70%-30% split than a 9% IRR with a 95%-5% split.

I recently spoke to an investor who invested $100,000 in a deal that offered very low fees along with an 88%-12% equity split. An 88%-12% split is quite generous. Sadly, however, at the end of one year, he received one check for only $200. That’s a terrible return on his investment. He would have been far better off to work with an experienced syndicator who would have offered him a 70%-30% equity split.

Even more so, if the sponsor is not being compensated well, they might not be committed to the deal, meaning that their incentive to invest their time and effort in a deal they are not making money on could be compromised. Not all sponsors are like that, and some (and rightly so) will still be incentivized in the deal because they want to maintain their reputation — but if they are not well compensated, do you want to take the chance and bet that they still would be incentivized?